Assignment M4
1: Discussion—ABC or Activity-Based Costing
In this discussion, we will examine a case study on Activity-Based Costing (ABC). The task involves calculating overhead allocations under existing methods, applying ABC to determine cost drivers and overhead costs for small and large advertising campaigns, and analyzing the implications for pricing strategies. The case details the operations and cost structures of Merit-o-cracy PLC, an advertising agency, including its cost classifications, activity levels, and campaign types. Key activities such as bidding for campaigns, winning campaigns, and servicing clients are linked to specific cost pools, which are to be analyzed for their impact on campaign costing. The objective is to understand how ABC can provide more accurate and strategic cost information for better decision-making and pricing adjustments.
Paper For Above instruction
Merit-o-cracy PLC, a well-established advertising agency, faces financial challenges due to its current costing and pricing methods. The company classifies its campaigns as small or large, with corresponding direct advertising costs of $4,000 and $28,000 respectively. Under the existing traditional method, these direct costs are augmented by a flat overhead markup of 100%, leading to calculated overhead allocations of $4,000 for small and $28,000 for large campaigns. However, this simplistic approach may distort true costs and obscure profitability analysis, especially given the differing complexities and resource utilizations of varying campaign sizes (Drury, 2018).
Traditional costing systems often allocate overhead broadly based on direct costs, assuming a uniform distribution of overheads across all campaigns regardless of their actual resource consumption. This approach may lead to undercosting large campaigns and overcosting smaller ones, thereby influencing pricing strategies and the agency’s ability to competitively bid for larger clients. Understanding this, Merit-o-cracy’s accountant has explored activity-based costing as a refined method that assigns overheads based on specific cost drivers associated with various activities within the agency (Cooper & Kaplan, 1991).
In order to implement ABC, the first step involves identifying relevant cost pools, which are groups of costs incurred due to specific activities. Based on management insights, the primary cost pools identified are creative staff, production staff, administrative & support staff, and rental costs. Each of these pools is driven by particular activity measures. Creative staff costs are linked to the number of campaigns the agency bids for, while production staff costs relate to the number of campaigns the agency wins.
Administrative and support costs are associated with the number of customers serviced, and rental costs are considered to be fixed and evenly shared among departments (Kaplan & Anderson, 2007).
The activity levels provided include: the agency bids for 800 campaigns (400 small, 400 large), wins 350 campaigns (325 small, 25 large), and services 400 customers (300 with small campaigns, 100 with large campaigns). The total annual overhead costs are $2 million, which are allocated initially based on the traditional method, resulting in $4,000 overhead per small campaign and $28,000 per large campaign, matching direct costs.
To apply ABC, the next step is to calculate the cost per activity driver within each pool. Based on the data, the cost drivers are the number of bids, the number of campaigns won, and the number of customers served. Assuming an equal division of rental costs among the three departments, the rental costs per department amount to $150,000 each, given the total rental cost of $450,000. The costs associated with creating and producing campaigns are linked to the activity levels in bids, wins, and customer accounts respectively.
Calculating the cost per driver for each pool reveals the following: the creative staff costs are $500,000, attributed to 800 bids, resulting in a cost per bid of $625. For production staff, $750,000 spread over 350 campaigns won yields approximately $2,143 per campaign. Administrative and support staff costs are $300,000, divided among 400 customers, resulting in $750 per customer.
Applying these unit activity costs to small and large campaigns, we note the number of bids and wins associated with each campaign size. Small campaigns account for 400 bids and 325 wins, while large campaigns involve 400 bids and 25 wins. The overhead costs assigned through ABC are calculated by multiplying the activity levels by their respective costs per driver. For example, the overhead for small campaigns from creative costs would be 400 bids × $625 = $250,000; for production costs, 325 wins × $2,143 = $696,975; and for administrative costs, 300 customers × $750 = $225,000.
Repeating similar calculations for large campaigns yields: 400 bids × $625 = $250,000; 25 wins × $2,143 = $53,575; 100 customers × $750 = $75,000. Summing these costs provides a more accurate picture of the overhead allocated to each campaign size based on activities rather than direct costs alone.
The percentage increase in overhead to be added to direct advertising costs under ABC, compared to traditional costing, becomes evident when these activity-based overheads are expressed as a proportion of direct costs. For small campaigns, ABC overhead is approximately $1,171,975, which, when divided by
the number of campaigns and their direct costs, results in a significantly different and more precise overhead rate—far exceeding the flat 100% markup of the traditional method. For large campaigns, ABC overhead totals $178,550, again reflecting more nuanced resource consumption.
This analysis demonstrates that activity-based costing allows Merit-o-cracy to better understand actual campaign costs, facilitating more strategic pricing. For example, under ABC, large campaigns may reveal higher or lower true costs than previously estimated, enabling the agency to adjust quotes to improve profitability and competitiveness. Additionally, the refined cost data helps identify inefficiencies and opportunities for resource optimization.
In conclusion, adopting activity-based costing provides Merit-o-cracy with a more transparent and accurate approach to allocating overheads. Through detailed analysis of activities and resource drivers, the agency can establish more realistic and profitable pricing strategies, ensuring sustainability in competitive markets. Effective implementation of ABC is essential for recalibrating the agency’s costing system to reflect actual resource usage, ultimately supporting better managerial decision-making and strategic planning (Kaplan & Anderson, 2007; Cooper & Kaplan, 1991; Drury, 2018).
References
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